Client Alert

SEC Warns Issuers about Misleading "Pro Forma" Financial Information in Earnings Releases

12/11/2001

On December 4, 2001, the Securities and Exchange Commission (the "SEC") issued SEC Release No. 33-8039 (the "Release"). The Release serves as a "warning" to public companies that issue earnings releases containing financial information prepared other than in accordance with United States Generally Accepted Accounting Principles ("GAAP"), commonly referred to as "pro forma" financial information1. In addition, the SEC reaffirmed its informal guidance on how to correctly present "pro forma" financial information in earnings releases.

The SEC recognized that there is no prohibition preventing public companies from publishing interpretations of their results or publishing summaries of GAAP financial statements. The Release also makes clear that "pro forma" financial information, with the appropriate disclosures about their composition and limitations, can be quite useful to investors. The focus of the SEC's concern is when "pro forma" financial information obscures GAAP results in earnings releases or otherwise misleads investors.

As many companies prepare to release their 2001 earnings and results of operations beginning in late January, the SEC reminded issuers and investors of the following principles:

  • The antifraud provisions of the federal securities laws apply to presentations of "pro forma" financial information in earnings releases, regardless of whether the releases are filed with the SEC.
  • If an earnings release contains financial information that is limited in scope (such as earnings before interest, taxes, depreciation and amortization ("EBITDA")), or that sets forth calculations of financial results on a basis other than GAAP, issuers must be mindful to fully and clearly explain the controlling principles underlying the "pro forma" financial information. For example, a presentation of earnings before "unusual or nonrecurring transactions" must include a description of the particular transactions and kinds of transactions that are omitted and consistently apply the methodology described when presenting purportedly comparable information about other periods.
  • Information should not be omitted from "pro forma" presentations where the omitted information is material. For example, investors are likely to be misled if a company uses "pro forma" financial information to recast a loss as a profit, or to obscure a material result of GAAP financial statements, without clear and comprehensible explanations of the nature and size of the omissions.
  • A "pro forma" financial presentation that focuses on a limited feature of financial results, or that is not prepared in accordance with GAAP generally will not be deemed to be misleading due to its deviation from GAAP if the company also discloses in the same release in plain English how it has deviated from GAAP and the amounts of each of those deviations.
  • The earnings press release guidelines jointly issued by the Financial Executives International and the National Investors Relations Institute ("FEI/NIRI guidelines") provide a useful model to consider before determining whether to include "pro forma" financial information in an earnings release or deciding how to structure a "pro forma" statement. The FEI/NIRI guidelines, published in April 2001, were intended to improve consistency among companies for the presentation and analysis of results. They call for earnings press releases to include any "pro forma" information together with GAAP results. They also state that while "pro forma" numbers are often used to supplement a period's GAAP results, and may clarify a company's performance during that period and discuss its future prospects, GAAP results provide the critical framework for evaluating "pro forma" results. In this regard, the FEI/NIRI guidelines state that "pro forma" results should always be accompanied by a clearly described reconciliation to GAAP results. To view the FEI/NIRI guidelines in their entirety.
  • Investors should be cautious and compare any summary or "pro forma" financial information with the GAAP results reported by the same company.

It is interesting to note that the Release does not provide any "new" guidance on how to prepare and present "pro forma" financial information in earnings releases. For years, the SEC staff has been reminding issuers of the need to balance "pro forma" financial information with its GAAP results. Though many companies have been making a visible effort to conform their "pro forma" earnings releases to most or all of the SEC's guidelines, the Release should still serve as a "warning" to all issuers that in the months ahead, the SEC's enforcement staff is likely to increase its scrutiny of earnings releases and seek penalties against issuers who publish misleading "pro forma" financial information.


1: The phrase "pro forma" financial information as used in the context of earnings releases has no specific defined meaning and should not be confused with the "pro forma" financial information for mergers and other transactions required by the SEC's rules, such as Article 11 of Regulation S-X.

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